Lockheed Martin 2007 Annual Report Download - page 45

pension accounting rules by 2010 to better align the recovery of pension contributions on U.S. Government contracts with
the new accelerated funding requirements. The new funding requirements for large U.S. defense contractors will be delayed
until the earlier of 2011 or the year in which the changes to the CAS rules are effective.
Critical Accounting Policies
Contract Accounting / Revenue Recognition
Approximately 84% of our sales are derived from long-term contracts for design, development and production activities,
with the remainder attributable to contracts to provide other services that are not associated with design, development or
production activities. We consider the nature of these contracts and the types of products and services provided when we
determine the proper accounting method for a particular contract.
Accounting for Design, Development and Production Contracts
Generally, we record long-term, fixed-price design, development and production contracts on a percentage of
completion basis using units-of-delivery as the basis to measure progress toward completing the contract and recognizing
sales. For example, we use this method of revenue recognition on our C-130J tactical transport aircraft program and Multiple
Launch Rocket System program. For certain other long-term, fixed-price design, development and production contracts that,
along with other factors, require us to deliver minimal quantities over a longer period of time or to perform a substantial level
of development effort in comparison to the total value of the contract, sales are recorded when we achieve performance
milestones or using the cost-to-cost method to measure progress toward completion. Under the cost-to-cost method of
accounting, we recognize sales based on the ratio of costs incurred to our estimate of total costs at completion. As examples,
we use this methodology for our F-22 Raptor program and the AEGIS Weapon System program.
In some instances, long-term production programs may require a significant level of development and/or a low rate of
initial production units in their early phases, but will ultimately require delivery of increased quantities in later, full rate
production stages. In those cases, the revenue recognition methodology may change from the cost-to-cost method to the
units-of-delivery method as new contracts for different phases of a program are received after considering, among other
factors, program and production stability. As we incur costs under cost-reimbursement-type contracts, we record sales and an
estimated profit. Cost-reimbursement-type contracts include time and materials and other level-of-effort-type contracts.
Examples of this type of revenue recognition include the F-35 Lightning II Joint Strike Fighter System Development and
Demonstration (SDD) program and the THAAD missile defense program. Most of our long-term contracts are denominated
in U.S. dollars, including contracts for sales of military products and services to foreign governments conducted through the
U.S. Government (i.e., foreign military sales).
As a general rule, we recognize sales and profits earlier in a production cycle when we use the cost-to-cost and
milestone methods of percentage of completion accounting than when we use the units-of-delivery method. In addition, our
profits and margins may vary materially depending on the types of long-term contracts undertaken, the costs incurred in their
performance, the achievement of other performance objectives, and the stage of performance at which the right to receive
fees, particularly under incentive and award fee contracts, is finally determined.
Incentives and award fees related to performance on design, development and production contracts, which are generally
awarded at the discretion of the customer, as well as penalties related to contract performance, are considered in estimating
sales and profit rates. Estimates of award fees are based on actual awards and anticipated performance. Incentive provisions
which increase or decrease earnings based solely on a single significant event are generally not recognized until the event
occurs. Such incentives and penalties are recorded when there is sufficient information for us to assess anticipated
performance.
Accounting for design, development and production contracts requires judgment relative to assessing risks, estimating
contract revenues and costs, and making assumptions for schedule and technical issues. Due to the size and nature of the
work required to be performed on many of our contracts, the estimation of total revenue and cost at completion is
complicated and subject to many variables. Contract costs include material, labor and subcontracting costs, as well as an
allocation of indirect costs. We have to make assumptions regarding labor productivity and availability, the complexity of the
work to be performed, the availability of materials, the length of time to complete the contract (to estimate increases in wages
and prices for materials), performance by our subcontractors, and the availability and timing of funding from our customer.
For contract change orders, claims or similar items, we apply judgment in estimating the amounts and assessing the potential
for realization. These amounts are only included in contract value when they can be reliably estimated and realization is
considered probable. We have accounting policies in place to address these as well as other contractual and business
arrangements to properly account for long-term contracts.
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